Mexico Is Looking Better Than It Has In A Long Time

Mark
Mobius is the Executive Chairman of Templeton Emerging
Markets Group. He currently directs analysts based in
Franklin Templeton's 18 emerging markets offices and
manages the portfolios. Dr. Mobius has spent more than 40
years working in global emerging markets and has received
numerous industry awards. He was named one of Bloomberg
Markets Magazine's "50 Most Influential People" in 2011 The
World Bank and Organization for Economic Cooperation and
Development appointed Dr. Mobius joint chairman of the
Global Corporate Governance Forum Investor Responsibility
Taskforce. He has authored several books on investing and
pens a blog, "Investment Adventures in Emerging Markets" at
mobius.blog@franklintempleton.com.

Recent Posts

Elections come and go, but the real test of a candidate might be
whether the promises made on the campaign trail are actually put
into place. Enrique Peña Nieto and his Institutional
Revolutionary Party (PRI) emerged victorious in Mexico’s July 1
presidential election on the promise of reform and the end to
old, “undemocratic” ways. Mexico’s stock market reacted
positively to the initial election results; Mexico’s IPC Index
(Indice de Precios y Cotizaciones) rose to a new all-time high in
June and extended those gains in July.1 While the
final election results are still in dispute, I’m encouraged by
the economic progress being made in Mexico, and optimistic about
its potential—assuming Mexico doesn’t backslide into
counterproductive politics and policies.

Time will tell whether the “new” PRI has truly changed its ways,
but the election (and the fallout afterward) has proven that
Mexico’s people seem hungry for change. Assuming Nieto’s win
holds up amid post-election vote challenges, when he takes office
in December he will need the support of allies in both houses of
Mexico’s Congress to aid his ambitious agenda. Nieto pledged a
number of structural labor, tax, business and social security
reforms designed to fuel Mexico’s economy.

In my view, the key reforms Mexico needs to improve its global
competitiveness and strengthen its economy are the proposed
fiscal, labor and energy reforms. The fiscal reforms aim to
increase government revenues to improve Mexico’s infrastructure,
facilitate investment, provide quality services and foster
economic growth. The plan to achieve this goal is to lower taxes
and broaden the taxpayer base. Mexico has a large informal
sector (a generally unmonitored or supported part of the
economy), and it often does not pay taxes. The goals for labor
reform include increasing productivity by improving workers’
conditions, promoting a meritocracy within corporations,
promoting equality among employees and placing limitations on
strikes.

Plentiful oil is one of Mexico’s strongest assets, but the
industry could benefit from improved production efficiency and
new exploration efforts to help stem a decline in output. Nieto’s
“signature policy” goal is to open state-controlled oil and
petrochemicals to private investment. I think a plan to allow
private companies to own stakes in oilfields through joint
ventures could emerge as a compromise to more ambitious
privatization plans, and pave the way for Nieto to tackle
monopolies and duopolies in other Mexican industries.

U.S. Ties a Double-Edged Sword

Mexico’s close ties to its neighbor to the north can be a
double-edged sword. Mexico exports some 80% of all its products
to the U.S. and is its largest oil supplier, so the Mexican
economy benefits from increasing U.S. demand. On the flip side,
however, when the U.S. suffers economic downturns, Mexico tends
to suffer in tandem. The 2008 – 2009 U.S. financial market crisis
had a ripple effect on Mexico’s economy, causing its GDP to sink
more than 6% in 2009, the worst contraction there in
decades.2

However, Mexico was able to quickly turn things around, taking
fiscal medicine that included government spending cuts. According
to the IMF, Mexico’s GDP growth was 5.6% in 2010, and 3.9% in
2011. This year many countries are struggling to maintain
economic momentum, but in its mid-year report, the IMF lifted
Mexico’s 2012 GDP growth forecast to 3.9%.3 Mexico’s
growth rate looks to potentially outpace the U.S. this year, and
it boasts a lower unemployment rate, too. Mexico’s foreign
reserves rose to a record of more than US$150 billion this
year,4 and its public debt-to-GDP ratio stood at 37.5%
in 2011, lower than some of its Latin American counterparts
(including Brazil).5 In my view, Mexico’s economy
appears to be in pretty good shape to help weather current global
challenges.

Risks and Potential

Mexico is seen by some as an underdog in Latin America. There are
a lot of “ifs,” but I think it could be possible for Mexico to
someday overtake Brazil as Latin America’s largest economy.
Improvement in security, successfully implementing the
aforementioned reforms, and of course the U.S. economy’s
performance all play important roles. Right now one could argue
Mexico is in better shape than Brazil for a few reasons; Mexico
is less indebted, the government plays a smaller role in the
economy (based on percentage of GDP), and inflation seems to be
more under control in Mexico, although always something that
bears watch.

Mexico’s inflation rate hit an 18-month high of 4.3% in June (as
measured by the consumer price index)6, which is a bit
of concern, and I think in part why the Bank of Mexico left
its overnight lending rate unchanged at 4.5% in July. At the
meeting, the central bank reported that while the short-term
inflation risk had accelerated, annual core inflation remains
stable in line with its expectations. Mexico imports about
20-30% of its corn consumption, so this year’s hot, dry U.S.
summer withering the corn crop there creates a potential risk.
Consumer sentiment is very sensitive to increases in the price of
tortillas, which are a national staple. It wouldn’t surprise me
if the government intervened, and I also think it’s possible we
could see a slight upward revision in inflation estimates. Right
now, corn is not the only factor increasing the risk. The prices
of eggs and chicken have risen significantly because of a virus
that has hit some farms in Mexico. This virus does not affect
humans.

Manufacturing and Trade

Mexico is undergoing interesting changes. I have seen first-hand
how Mexico is evolving from a “maquila” economy producing lower
value-added products to a highly technological advanced
manufacturer. Large manufacturers searching for low-cost, highly
skilled labor are setting up operations in Mexico, including
areas you might not expect, such as aviation and autos. I
recently visited an industrial park in Queretaro which housed
suppliers and R&D efforts, and there are other similar
centers in the Northern part of Mexico.

Mexico’s geographical proximity to the U.S. allows many U.S.
companies to manufacture goods more cheaply there than in China,
benefiting from logistical efficiencies. While U.S. manufacturers
have been outsourcing production to Mexico for some time, rising
wages in China could lead even more to turn to Mexico as a
low-cost labor alternative.

While the bulk of Mexico’s exports wind up in the U.S., more than
90% of Mexico’s trade is under free trade agreements encompassing
more than 50 countries including Canada, Guatemala, Honduras, El
Salvador, the Eurozone, and Japan.1 Mexico has also
been asked to join the “TransPacific Trade Partnership,” an
ambitious new Pacific Rim trade partnership that could help
diversify its export base.

In the past few years, much-publicized violence took a toll on
Mexico’s image, and its economic growth looked lackluster
compared with some other Latin American countries. It remains to
be seen just how Nieto and the PRI handle a legacy of corruption
and crime, instill confidence in its people and turn around
Mexico’s image in the eyes of the world. Nonetheless, aided by an
aggressive public relations campaign7, tourism has
been holding up well despite the bad press; Mexico’s Tourism
Board estimates that this year, the number of international
visitors looks on track to break last year’s record of 22.67
million. While most of Mexico’s visitors are from the U.S.,
increasing numbers of tourists from emerging markets are
recognizing the beauty of Mexico’s beaches and its cultural
riches.

Investing in Mexico

Investors are recognizing the attractiveness of Mexico as an
investment destination now, too. From an investment standpoint,
my team likes the energy sector, as it could potentially benefit
from reform efforts. And, while oil is subject to short-term
price fluctuations, global consumption is expected to grow in the
long-term as vehicle sales in emerging nations such as India and
China are expected to remain on an upward trajectory and of
course, for its pervasive use in industry. We also like the
consumer story. Consumer staples, banking and telecommunications
are areas of interest, and we think increased privatization and
foreign investment should increase their attractiveness. The
Eurozone crisis has given many emerging market companies the
opportunity to acquire European brands at attractive prices, and
Mexican companies are among them.

Without a Congressional party majority, it may take some
wrangling for Nieto to deliver on his campaign promises, but I’m
optimistic that if even more limited progress can be made, the
future holds potential for Mexico.

1. Past performance does not guarantee future results.
An index is unmanaged and one cannot invest directly in an
index.